Amy Hood
Executive Vice President and Chief Financial Officer at Microsoft
Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $69.6 billion, up 12%. Gross margin dollars increased 13% and 12% in constant currency, while operating income increased 17% and 16% in constant currency. Earnings per share was $3.23, an increase of 10%. We delivered another quarter of double-digit top and bottom line growth. Results were driven by strong demand for our cloud and AI offerings, while we also improved our operating leverage with higher-than-expected operating income growth. As you heard from Satya, our AI business annual revenue run rate surpassed $13 billion and was above expectations. Commercial bookings increased 67% and 75% in constant currency and were significantly ahead of expectations, driven by Azure commitments from OpenAI. Execution was strong across our core annuity sales motions, with growth in the number of $100 million-plus contracts for both Azure and Microsoft 365. Commercial remaining performance obligation increased to $298 billion, up 34% and 36% in constant currency. Roughly 40% will be recognized in revenue in the next 12 months, up 21% year-over-year. The remaining portion recognized beyond the next 12 months increased 45%. And this quarter, our annuity mix was 97%. FX did not have a significant impact on our results and was roughly in line with expectations on total company revenue, more personal computing revenue, total company COGS and operating expense. FX decreased revenue more than expected in our commercial segments. Microsoft Cloud revenue was $40.9 million and grew 21%. Microsoft Cloud gross margin percentage was 70%, in line with expectations and decreased 2 points year-over-year, driven by scaling our AI infrastructure. Company gross margin percentage increased slightly year-over-year to 69%, primarily driven by sales mix shift to higher margin businesses as well as improvement in gaming and search, partially offset by the impact of scaling our AI infrastructure. Operating expenses increased 5% lower than expected and operating margins increased 2 points year-over-year to 45%. The better-than-expected margin expansion was driven by delivering efficiencies across our businesses as we invest to scale AI infrastructure and build AI applications. At a total company level, headcount at the end of December was 2% higher than a year ago and was relatively unchanged from last quarter. Now to our segment results. Revenue from Productivity and Business Processes was $29.4 billion and grew 14% and 13% in constant currency even with the unfavorable FX impact noted earlier. Results were ahead of expectations driven by Microsoft 365 Commercial. Microsoft 365 Commercial Cloud revenue increased 16% and 15% in constant currency, slightly ahead of expectations due to better-than-expected performance in E5 and Microsoft 365 Copilot. With M365 Copilot, we continue to see growth in adoption, expansion and usage. ARPU growth was again driven by E5 and M365 copilot. Paid M365 commercial seats grew 7% year-over-year, with all base expansion across all customer segments though primarily in our small and medium business and frontline worker offerings. M365 Commercial products revenue increased 13% significantly ahead of expectations, driven by higher-than-expected transactional purchasing with the launch of Office 2024 as well as the Windows Commercial on-premises components from the better-than-expected formats of M365 suite noted earlier. M365 Consumer Cloud revenue increased 8%, slightly ahead of expectations. We saw continued momentum in M365 consumer subscriptions, which grew 10% to $86.3 million with mix shift to M365 basic. LinkedIn revenue increased 9% with continued growth across all lines of business. In our Talent Solutions business, results were slightly below expectations driven by continued weakness in the hiring market in key verticals. Dynamics 365revenue increased 19% and 18% in constant currency, slightly ahead of expectations with growth across all workloads. Segment gross margin dollars increased 13% and 12% in constant currency, and gross margin percentage increased slightly year-over-year, driven by scaling our AI infrastructure. Operating expenses increased 6% and operating income increased 16% and 15% in constant currency. Next, the Intelligent Cloud segment. Revenue was $25.5 billion and grew 19% with more unfavorable FX impact than expected. Excluding the unfavorable FX impact, results in Azure non-AI services, on-prem server and enterprise and partner services were slightly lower than expected partially offset by better-than-expected results in Azure AI services. Azure and other cloud services revenue grew 31% and Azure growth included 13 points from AI services, which grew 157% year-over-year and was ahead of expectations even as demand continued to be higher than our available capacity. Growth in our non-AI services was slightly lower than expected due to go-to-market execution challenges, particularly with our customers that we primarily reach through our scale motions, as we balance driving near-term non-AI consumption with AI growth. In our on-premises server business, revenue decreased 3%, slightly below expectations, driven by slower-than-expected purchasing around Windows Server 2025 launch. Enterprise and Partner Services revenue decreased 1%, below expectations with lower-than-expected performance across enterprise support services and Industry Solutions. Segment gross margin dollars increased 12% and 13% in constant currency, and gross margin percentage decreased 4 points year-over-year driven by scaling our AI infrastructure. Operating expenses increased 2% and operating income grew 14%. Now to More Personal Computing. Revenue was $14.7 billion, relatively unchanged year-over-year, with better-than-expected results driven primarily by Windows OEM prebuilds, usage from a third-party partnership in search as well as Call of Duty launch performance in gaming. Windows OEM and devices revenue increased 4% year-over-year ahead of expectations, driven by commercial inventory builds in advance of Windows 10 end of support as well as uncertainty around tariffs. Search and news advertising revenue ex TAC increased 21% and 20% in constant currency, ahead of expectations, driven by usage from a third-party partnership. Growth continues to be driven by rate expansion and healthy volume growth in both Edge and Bing. And in Gaming, revenue decreased 7% and 8% in constant currency as content and services growth continued to be offset by hardware declines. Xbox content and services revenue increased 2% ahead of expectations driven by stronger-than-expected performance in Blizzard and Activision content, including Call of Duty. Segment gross margin dollars increased 13% and 12% in constant currency. Gross margin percentage increased 6 points year-over-year driven by sales mix shift to higher margin businesses as well as strong execution on margin improvement in gaming and search. Operating expenses decreased 1%. Operating income increased 32% and 30% in constant currency, driven by continued prioritization of higher-margin opportunities. Now back to total company results. Capital expenditures, including finance leases, were $22.6 billion, in line with expectations and cash paid for PP&E was $15.8 billion, more than half of our cloud and AI-related spend was on long-lived assets that will support monetization over the next 15 years and beyond. The remaining cloud and AI spend was primarily for servers, both CPUs and GPUs, to serve customers based on demand signals and meeting our customer contracted backlog. Cash flow from operations was $22.3 billion, up 18% and driven by strong cloud billings and collections, partially offset by higher supplier employee and tax payments. Free cash flow was $6.5 billion, down 29% year-over-year, reflecting the capital expenditures noted earlier. This quarter, other income and expense was negative $2.3 billion lower than our October guidance due to the impairment charge from our cruise investments. Our effective tax rate came in slightly lower than anticipated at 18%. And finally, we returned $9.7 billion to shareholders through dividends and share repurchases. Now moving to our Q3 outlook which unless specifically noted otherwise, is on a U.S. dollar basis. First, FX. With the strengthening of the U.S. dollar since October, we now expect FX to decrease total revenue growth by 2 points. Within the segments, we expect FX to decrease revenue growth by 2 points in Productivity and Business Processes and Intelligent Cloud and roughly one point in more personal computing. When compared to our October guidance assumptions on Q3 FX impact, this is a decrease to total revenue of roughly $1 billion. We expect FX to decrease COGS growth by approximately 2 points operating expense growth by approximately one point. Our outlook has many of the trends we saw in Q2 continue through Q3. Demand for our differentiated cloud and AI offerings across the Microsoft Cloud to drive another quarter of strong growth. In commercial bookings, with a relatively flat pre base and the strong prior year comparable in terms of large Azure contracts, we expect growth to be roughly flat year-over-year. We expect consistent execution across our core annuity sales motions and continued long-term commitments to our platform. As a reminder, larger long-term Azure contracts, which are more unpredictable in their timing, can drive increased quarterly volatility, which are more unpredictable in their timing, can drive increased quarterly volatility in our bookings growth. Microsoft Cloud gross margin percentage should be roughly 69%, down year-over-year, driven by the impact of scaling our AI infrastructure. Next, to segment guidance. In Productivity and Business Processes, we expect revenue to grow between 11% and 12% in constant currency or $29.4 billion to USD29.7 billion. Microsoft 365 Commercial Cloud revenue growth should be between 14% and 15% in constant currency, relatively stable compared to our better-than-expected Q2 results. We expect continued ARPU growth through E5 and M365 Copilot and we again expect some seat growth moderation given the size of the installed base. For M365 Commercial products, we expect revenue to be relatively unchanged year-over-year. As a reminder, M365 Commercial products include Windows Commercial on-premise components of M365 suites. So our quarterly revenue growth can have variability primarily from in-period revenue recognition depending on the mix of contracts. M365 Consumer Cloud revenue growth should be in the mid- to high single digits, driven by M365 subscriptions. For LinkedIn, we expect revenue growth in the low to mid-single digits. Although we expect growth across all businesses, the Q2 trends in Talent Solutions should continue in Q3 as a headwind to growth. And in Dynamics 365, we expect revenue growth to be in the mid-teens, driven by continued growth across all workloads. For Intelligent Cloud, we expect revenue to grow between 19% and 20% in constant currency or $25.9 billion to USD26.2 billion. Revenue will continue to be driven by Azure, which, as a reminder, can have early variability primarily from in-period revenue recognition depending on the mix of contracts. In Azure, we expect Q3 revenue growth to be between 31% and 32% in constant currency, driven by strong demand for our portfolio of services. As we shared in October, the contribution from our AI service will grow, from increased AI capacity coming online. In non-AI services, healthy growth continues, although we expect ongoing impact through H2 as we work to address the execution challenges noted earlier. And while we expect the AI capacity constrained in Q3, by the end of FY '25 should be roughly in line with near-term demand given our significant capital investments. In our on-premise server business, we expect revenue to decline in the mid-single digits, driven by a decrease in transactional purchasing. In Enterprise and Partner Services, we expect revenue growth to be in the low to mid-single digits. In More Personal Computing, we expect revenue to be USD12.4 billion to USD12.8 billion with continued prioritization of higher-margin opportunities. Windows OEM and Devices revenue should decline in the low to mid-single digits. We expect revenue from Windows OEM to be relatively flat year-over-year as our outlook assumes inventory levels will normalize. Actual results may differ based on current tariff uncertainties. Devices revenue will decline. Search and news advertising ex TAC revenue growth should be in the mid-teens from continued growth in both volume and revenue per search, with share gains across Edge and Bing. Growth is expected to moderate from last quarter, primarily due to additional FX impact. And as the third-party partnership usage noted earlier, returns to more normal levels. Search ex TAC growth will be higher than overall search and news advertising revenue growth, which we expect to be in the mid- to high single digits. And in Gaming. We expect revenue growth to be in the low single digits. We expect Xbox content and services revenue growth to be in the low to mid-single digits, driven by first-party content as well as Xbox Game Pass. Hardware revenue will decline year-over-year. Now back to company. We expect COGS to grow between 19% and 20% in constant currency or to be between $21.65 billion to USD21.85 billion and operating expense to grow between 5% and 6% in constant currency or to be between USD16.4 billion and USD16.5 billion. Other income and expense is expected to be roughly negative $1 billion, primarily driven by investments accounted for under the equity method. As a reminder, we do not recognize mark-to-market gains or losses on equity method investments. And lastly, we expect our Q3 effective tax rate to be approximately 18%. Now some additional thoughts on the rest of the fiscal year and beyond. First, FX. With the strengthening of the U.S. dollar since October, we now expect FX to decrease Q4 revenue and COGS growth by more than one point and operating expense growth by roughly one point. Next, capital expenditures. We expect quarterly spend in Q3 and Q4 to remain at similar levels as our Q2 spend. In FY '26, we expect to continue investing against strong demand signals, including customer contracted backlog we need to deliver against across the entirety of our Microsoft Cloud. However, the growth rate will be lower than FY '25 and the will begin to shift back to short-lived assets, which are more correlated to revenue growth. As a reminder, our long-lived infrastructure investments are fungible enabling us to remain agile to meet customer demand globally across our Microsoft Cloud, including AI workloads. As always, there can be quarterly spend variability from cloud infrastructure build-outs and the timing of delivery of finance leases. For the full fiscal year, we continue to expect double-digit revenue and operating income growth as we focus on delivering efficiencies across both COGS and operating expense. And given the operating leverage that we've delivered throughout the year, inclusive of efficiency gains as we scale our AI infrastructure and utilize our own AI solutions, we now expect FY '25 operating margins to be up slightly year-over-year. And finally, our FY '25 full year effective tax rate should be between 18% and 19%. In closing, we are committed to delivering real-world AI solutions to help customers grow and improve their results. We are confident in our leadership position as we grow with our customers. Before turning to Q&A, I have one special thank you. Brett Iversen is moving to a new role here as the Head of our Americas. On behalf of the company, thank you for your tremendous impact, leading Investor Relations for the past 4 years and for the partnership with both Satya and me. And I'd like to welcome Jonathan Neilson, the former Head of Finance for our security products, who is returning to Investor Relations to lead the team. With that, let's go to Q&A, Brett.
